Research & Forecast Report – Q3 Houston Office Market Research & Forecast Report

Excerpts from Q3 Houston Office Market Research & Forecast Report by Colliers International  

Houston Suburban Office Market Continues to Outpace CBD

Houston’s office market at the close of 3Q 2010 showed a slight improvement from the previous quarter, with a stronger performing suburban sector, compared to the Central Business District (CBD). Although leasing activity picked up, vacancy increased slightly. Year-over-year change in office occupancy citywide was moderate with 83.3 percent occupancy at the end of the third quarter compared to 83.8 percent in the same quarter last year. Quoted rental rates citywide for Class A space decreased 0.4 percent, with the CBD Class A decreasing 2.0 percent to $35.16 per square foot, while suburban Class A space decreased a minimal 0.2 percent to $27.30 per square foot. Net absorption also showed the combined suburban markets outperforming the CBD. While the CBD’s year-to-date net absorption was negative 553,516 square feet, the suburban markets’ combined net absorption was positive at 242,261 square feet. Even with weak pockets scattered citywide, the suburban market trends continue to indicate this sector will plateau sooner, and will likely lead the office market recovery.

Looking forward, several key events are contributing to a more cautious outlook for the local downtown office market over the next 6 – 12 months. The recently approved merger between Houston-based Continental Airlines and Chicago-based United Airlines expected to close by year-end will not negatively impact CBD Class A occupancy in the near-term. According to a source close to the deal, Continental’s lease doesn’t expire until 2014 and the space will not be offered for sublease for 12-24 months. The top concern for the CBD Class A market is the completion of speculative new construction. Hines’ 972,474-square-foot MainPlace is currently 10 percent leased and expected to be completed by February 2011. Securing an anchor tenant before final delivery, however, remains a possibility as was the case with the only other new office building underway downtown – Trammell Crow Company’s 844,763-square-foot Hess Tower – 100 percent pre-leased to Hess Corporation and scheduled to open in October 2010.

According to the Texas Labor Market Review, Texas MSAs have experienced job gains in six out of eight months so far this year. Although Houston isn’t the top performing MSA in Texas, Houston continues to be recognized as one of the strongest metros in the U.S. for business activity, with the employment sector reporting marked improvement from this time last year. In the 12 months ending in August 2010, Houston’s job loss totaled 18,300, significantly below the 100,000 jobs lost in 2009, with the local MSA projected to end 2010 with positive job growth. The area’s above-average population growth spurring the need for increased services is also a positive contributing factor in Houston’s strong long-term outlook.

OCCUPANCY & AVAILABILITY

With the exception of suburban Class B properties, occupancy levels citywide have decreased at a slow pace over the past year. Houston’s office occupancy for all property classes averaged 83.3 percent in the second quarter, compared to 83.8 percent this time last year. Despite the incremental decreases, however, the ongoing softness in the employment sector is not likely to reverse current occupancy trends in the near future.

In the CBD, top-tier properties’ resilience waned between quarters, inching up into double-digit vacancy, with Class A occupancy at 89.9 percent, compared to 91.2 percent one year ago. In sharp contrast, the CBD Class B posted 76.9 percent occupancy, down from 78.3 percent 12 months earlier.

While the overall suburban occupancy rate remained relatively flat between quarters, double-digit vacancy continued for all suburban property classes at midyear. Suburban Class A occupancy fell to 80.7 percent at the end of the third quarter from 87.4 percent last year. By comparison, suburban Class B occupancy rose a modest 0.1 percent to 83.5 during the same period.

Citywide, a total of 56 office properties had 100,000 square feet or more available for lease in both direct and sublease space – 16 of those properties have over 200,000 square feet available – at the end of the third quarter. Sublease space totaled 3.8 million square feet, including 2

million square feet of vacant space and 1.8 million square feet of subleases available for occupancy over the next 12 months. The largest sublease space being marketed is Devon Energy’s space, 281,755 square feet in Two Allen Center and 186,462 square feet in Three Allen Center (available for occupancy 4/2011) in the CBD. In Westchase, 2103 CityWestPlace has the largest suburban sublease space available, 128,770 square feet.

ABSORPTION & DEMAND

Houston recorded negative net absorption of 25,586 square feet in the third quarter, compared to 248,351 square feet negative net absorption at the same time last year. City-wide year-to-date net absorption is negative 311,225 square feet with CBD Class A product contributing most of that with year-to-date negative net absorption of 435,872 square feet, followed by CBD Class B with negative net absorption at 131,085 square feet. In contrast, suburban Class A and B have managed to maintain modest positive net absorption year-to-date with 72,499 and 101,149 square feet, respectively.

Prevailing economic uncertainty is likely to continue negatively impacting overall absorption levels through the end of 2010.

RENTAL RATES

After declining during the first two quarters of 2010, rental rates for all property classes remained relatively flat between quarters.

On a year-over-year basis, CBD Class A average quoted rental rates actually fell by 6.1 percent to $35.16 per square foot (from $37.45), while suburban Class A rates increased 1.7 percent to $27.30 per square foot. CBD Class B rates posted a 1.8 percent increase to $23.87 per square foot (from $23.46), while suburban Class B rates fell 0.4 percent to $17.88 per square foot on a full-service basis. While supply continues to

outpace demand, the current office tenants’ market is expected to continue through the end of the year.

SALES ACTIVITY

Investment sales activity in the third quarter remained at a slow pace with a handful of suburban properties changing hands. Year-to-date through the third quarter, office transactions totaled 29 with a total dollar volume of $948 million, averaging $205 per square foot with an 8.4 percent capitalization rate.

Among the most significant transactions closed in the third quarter are:

American National Insurance acquired the 153,345-square-foot Three Sugar Creek from Harry M. Green Interests for $28.5 million ($186 per square foot). Located in the E Ft Bend/Sugar Land submarket, the building was completed in 2007, and at the time of sale was 45 percent leased to Aetna.

Healthcare Trust of America acquired a 176,000-square-foot medical office building located at 7900 Fannin in the Medical Center from Stonehenge Development for $45.5 million ($257 per square foot).

Lincoln Property Co acquired Energy Crossing from M&I Bank. The six- story building located on I-10 at Hwy 6 was purchased with the adjacent 5.5 acres of land that is designed for additional office space as well as a 1.2 acre retail parcel. The sales price was not disclosed.

LEASING ACTIVITY

Houston’s office leasing activity reached 3.2 million square feet in the third quarter, compared to 3.9 million square feet in the same quarter last year. Although still below levels before the recession, an increasing number of office tenants are renewing lease commitments with better concession packages or relocating to buildings/submarkets offering more attractive terms.

Significant new office leases (non-renewal) signed in the third quarter

include: Weatherford International leased 335,000 Sq. Ft. at 2000 St. James Place, relocating from 515 Post Oak, both located in the Galleria submarket. Aker Solutions leased 133,417 Sq. Ft. at 3010 Briarpark, relocating from 3600 Briarpark, both located in the Westchase submarket.

The largest office lease renewal signed in the third quarter was Mustang Engineering’s early renewal of 248,872 square feet in Ten West Corporate Center II located in the Katy Freeway submarket.

Shell Oil Company signed the largest sublease during the quarter, 300,000 Sq. Ft. in 1000 Main located in the CBD submarket.

Criteria: Office buildings 20,000 SF >, multi and single tenant, absorption, rents vacancy include direct and sublease space. Stats exclude owner occupied government and medical.